Monday, December 12, 2016

A New Monetary System From Scratch, Part 4: Nick on a Trip

The central bank accountant follows two simple rules which he applies on a person-by-person basis: (1) if a person sells something, then credit her account, and (2) if a person buys something, then debit her account.

What is being recorded is how much each person has given or taken,
without paying attention to who happened to be the counterparty in any
particular trade. We know that Andy has taken goods worth SK100; from
whom, it doesn't matter. We also know that Betty has given goods worth
SK100; to whom, it doesn't matter. [1]

Before we delve further into the principles of this record-keeping system, let's assume that right after meeting Betty, Andy bumps into Carol and sells her apples priced at SK100. Following rule 1 (see quote above), the central bank credits Andy's account with SK100 and, following rule 2, debits Carol's account with SK100.

The central record-keeper was duly informed, through an electronic trade reporting system (ETRS), about both of these trades and made the following entries on people's accounts (I use "T-accounts" as visual aids):

(We could close the "circle" or "triangle" by having Carol sell carrots to Betty for SK100, but I don't want to do that. In reality, we always have some open balances.)

To remind you of the purpose of this record-keeping system, here's what I said in Part 2:

Our new monetary system is about keeping records of gifts given and gifts received
by each person. Betty gives a gift and this (transaction) is recorded
by making a credit/positive entry – the nominal value of which reflects
the value of the gift expressed in terms of the abstract unit-of-account
– on her account. Andy receives a gift and this (transaction) is
recorded by making a debit/negative entry on his account. Nothing moves
from Andy's account to Betty's account, or vice versa. There's only a
real-world 'banana flow' from Betty to Andy.

When we look at the three accounts above, we can see that Andy's overall net trade is zero (he is "even"), Betty has a credit worth SK100 and Carol has a liability worth SK100. We also know that, in keeping with the "multilateral gift economy" concept, Carol doesn't owe Betty (in particular). Carol could sell carrots to anyone and in this way get rid of her liability.

Nick's world

Let us now compare our system to the monetary system Nick Rowe made from scratch here (see also my Part 1).

Let's assume Nick Rowe is "airlifted" into our imaginary economy. Not being able to speak the language, Nick has to rely on his deep understanding of both trade and accounting when he tries to make sense of the exchange system.

Nick arrives just in time to witness Andy selling apples to Carol. The first thing which catches Nick's attention is that goods flow only in one direction.

"The economy might be primitive, but at least they don't rely on barter", he mumbles.

Nick also notices that the buyer of the goods, Carol, uses some kind of electronic gadget. The seller, Andy, has a gadget, too. Right after Carol has typed something in her gadget, Andy's gadget beeps. Andy looks at the screen and gives a thumbs-up to Carol. After this, they separate.

"OK. The economy cannot be that primitive", says Nick to himself. He is quite sure they are using some kind of electronic money in this economy.

Nick is thirsty and he walks into the first building that comes his way. Unfortunately, it's not a bar. It's the central bank.

Nick seems harmless enough, so the central banker lets him have a look at the electronic ledger (an unrealistic assumption, but a fairly harmless one?). There are a lot of accounts, but only three of them have had any entries made on them, and only two have open balances (see T-accounts above).

Now Nick has seen all he needed to see in order to be able to explain how the exchange system in this economy works.

Nick explains:

First of all, we are talking about a monetary exchange economy, not unlike ours.

In Trade 2, Andy sold apples to Carol. With the apples, Andy also delivered 100 red skilos (a medium of exchange) to Carol, thus getting rid of his liability. Now Carol is in possession of 100 red skilos.

Betty has 100 green skilos on her account and she can transfer those, as a payment, to the seller if she wants to buy some goods.

The medium of exchange, skilo, serves also as a unit of account.

[Nick continued about velocity of skilos, about IS-LM models, and so on. I left it out here because I wasn't able to follow his thought.]

[1] Probably I should have said "...without paying undue attention to
who happened to be the counterparty...". The two entries made by the
central record-keeper (central bank) do reveal the counterparty, but the
point I wanted to make was that the trade doesn't establish any
on-going relationship between the two parties to it. For all we know,
they could be strangers to each other.

26 comments:

I must admit, I don't understand why Nick's logic apparently does not apply to a mortgage (as per his reply to you over at WCI). Do you?And what bothers me in the analogy is that the coloured bits of paper just 'appear' and 'disappear' without notice. If course, it couldn't be any other way, but it sort of defeats the point of using a physical analogy in the first place. But I suppose I'm preaching to the choir here.

The problem is that in order to understand Nick, not only do we need to be able to read his logic but also his mind. After all, I seem to be challenging long-held "facts".

M and Nick are like M and James Bond. It's hard to imagine one without the other.

I need to come up with a good answer to his "M and D book" argument. There might be a small chance here for a good discussion, and that's why I should try to avoid confronting that argument head-on. I'll think about it over lunch :-)

The physical analogy is useless ("pure" accounting says the same but better), but it seems it's the only way Nick can hold to M as a medium of exchange. The MoE idea has always relied on M being a "counter" (if not physical, then electronic), and as I argued in my earlier post, there are no counters on accounts. I think this could be the underlying reason for Nick wanting to insist that it is observationally equivalent to think that the accountants put counters in people's shoebox-accounts and move those counters between the boxes -- that makes those counters a MoE.

Makes some sense?

As you see, in my description of the economy there are no counters and no MoE (naming the whole system as MoE would be understandable but probably misleading).

Still I'm describing the same system as Nick is. Aren't I? If we jump a few generations forward, Andy's and Betty's grand-grandchildren might be using the same system, but being students of Nick's grandchildren, they might have got the idea that the system works like Nick says it works now. They'd be "transferring some skilos between their accounts" and they would have "money debts".

Maybe you have to introduce the O for overdrafts book and treat it like he treats the D book? It's just a (prearranged) loan of money. O could just be another fruit, say oranges. And away goes trouble down the drain...

:-) You mean that I should show that O-book is actually just like D-book, and because Nick thinks O-book is just a part of M-book, then D-book should be part of M-book as well? Might work.

I answered him now. What do you think of the approach? I'm going after a more direct way to include D-book in the M-book, by showing that M-book is not about holdings of M, and thus we can fit D-book in the M-book :-)

My comments on "digital money" were intended to show that there was no difference between periodic-recordings-of-position (which is accounting) and physical-objects used as counters. The only requirement for making the correlation is to have uniform intervals between the position-recordings.

A notation of $10,000 is identical to having a stack of 10,000 $1 coins.

Of course the coins could be duplicated into green and red models.

We have a problem if we want to have less than zero physical coins. On the other hand, less-than-zero accounting is easy (place a minus sign symbol before the measurement) but remember--the minus sign indicates that a second numbering system is in-use.

To me, negative numbers would be equivalent to red coins. A simple duplication of the measurement system.

Turning to the issue of MoE, I often think of physical money not as-a-counter but as a place-holder. Hence, I would rather hold 10,000 $1 coins than a car worth $10,000 when my goal is to buy a trip worth $10,000. When I am thinking of money as a place-holder, I am thinking about holding my position over a time period.

I may be wrong, but I basically interpret Nick's perspective as a framework which records asset-to-asset exchanges (ABC-to-M) and liability-to-asset exchanges (D-to-M) – the overall positions being residuals.

Reading Roger's comment above, I think the deeper discussion is whether money is a relative measure of things that economic agents own / owe or whether money itself is a thing that is owned / owed. The book keeping approach says that money divides the world into a finite number of (up) and (down) entries. If I sell you an apple, I am (up) an apple while you are (down) an apple. One can then say, I own 50 (ups). But you will have to admit that within the given grammar that doesn't really make much sense. Nor does owing an (up) make any sense. You are either up, in total or in relation to your ladt trading partner, or you are diwn by the same measure. It is an evonomic state relative to other agents that is being depicted by 'money'. That is why from the accounting perspective one has to cringe at the thought of calling money in aggregate 'net worth'. We cannot have a majority that is 'better off' (or worse off) than a minority at any point in time. 0 is the mean.

Roger: First, sorry for not answering your comments during the past week or so! I've been busy, and I felt that there is some confusion in your comments (you perhaps misinterpreting me) that I might be able to clear away with a new post.

You said: "A notation of $10,000 is identical to having a stack of 10,000 $1 coins."

I see what you mean. I say pretty much the same, but I turn it around. I told Nick that we must be able to explain the accounting without any reference to "counters". We must be able to abstract away from the counters, as if those had never existed, and all we had ever had was the accounting without physical counters.

Do you see what I mean? The world looks different when seen from that angle. The accounting records become primary, and then we don't, or at least shouldn't, think as if some electronic or imaginary counters were moving between accounts.

I think your "place-holder" is what is meant by "store of value"? I always view that in terms of aggregate usefulness, or utility, for the society. Think if we had to keep on piling the materials for our new house, from month to month and year to year, until we had managed to get everything we need to build the house. That would be such a waste of materials, which could have been used in building other houses instead of lying idle, or even worse, partly rottening, in a pile.

But the problem I see with that approach is that there is M, which is grouped with, or even equated to, real assets like A, B and C.

Instead, it looks like the M-book is best understood as records of trades involving A, B and C. No M is involved. If there is no M, then D-book cannot be what Nick says it is: records of debts of M. In that case, M-book and D-book actually belong together; both are records of trades involving A, B and C.

You said: "...Nick's perspective as a framework which records asset-to-asset exchanges (ABC-to-M)"

Now that I thought of this for a second time, this cannot be how Nick sees it. Because for Nick, M includes red money, a liability. To Nick, M is not an asset. M is a Medium of Exchange. That's the defining feature of M for Nick, and that's why he had to bring in red money, a liability. Because in the case of ovedrafts, Nick correctly sees no financial asset exchanged. (In Geva's book you linked to, he explicitly mentioned the possibility of using an overdraft, and so, he concluded, we cannot even talk about "bank's debt" being transferred from a non-bank to a non-bank.)

I think you are opening an interesting perspective. I hope I am reconstructing your thought in the path you have begun.

We should not be slaves to the +/- accounting perception of the balance sheet. If we DO THINK of +/- accounting as TWO numbering systems, then each side of the sheet is a reflection of the same system.

Hence, each side of the balance sheet represents a positive asset; the only difference is the character difference that caused us to record in two systems.

Roger: Long & short would be the corresponding terms in the finance world, if I'm not mistaken.

I wouldn't focus so much on the asset itself (which may well disappear when consumed, for example, or appreciate depreciate in value etc.) as on the moment in which it changed hands - the exchange - which is when the relative measurement is made. I don't think there's any escaping the accounting logic once you've accepted it. You can mask the liability side and only focus on the asset side of a balance sheet, which is how I see standard 'green money', or you can do the opposite, which is how I read that weird red money stuff. I'm more of the pedantic type, so I wouldn't go down either path.

I just had a glass of whisky, and our "critter" has ensured I'm slightly sleep-deprived, but let's see if I manage to write something sensible.

Do I agree with what you said?

You said: "You can mask the liability side and only focus on the asset side of a balance sheet, which is how I see standard 'green money', or you can do the opposite, which is how I read that weird red money stuff. I'm more of the pedantic type, so I wouldn't go down either path."

I said: "As I said earlier, it's the green-only world (and red-only world) which create the problems in this discussion. This is because green+red world is a world of ACCOUNTING, whereas green-only and red-only are worlds where there only exists CREDITS or DEBITS, not both. Makes no sense. Well, perhaps to a monetarist, but not to an accountant :-)"

Sounds like we agree?

By the way, you mentioned earlier that you have been(?) an architect. (Or did I dream this up?) I forgot to mention that I think that's cool. If I recall correctly, in Seinfeld George wished he could tell people that he is an architect or a marine biologist. Only later did I understood the deeper point behind it. I didn't feel I was saying something about who I am when I told people I met that I was a "financial analyst" or a "business analyst" (not unlike George!). Those people I met, through my wife, were often pianists, cellists, composers, conductors or painters.

Now I tell people that I work on economic theory, "crazy stuff", although I don't (yet) get paid for it :-)

Antti, you might be right. I must read up on the whole red money philosophy (which I have only glanced at)

Rushed thought: From a more traditional point of view the delivery of "red money" would have to register as a D-to-M (triangular) exchange. But then again, so would the delivery of "greens". I would assume there's a third party implicated?

Or, I've misunderstood Nick completely, and the M-book simply denotes to a measure of the velocity of money Y/M and the D-book to ΔM?

Architecture is nowhere near as cool or romantic as it may sound to an outsider. 99% of the planning and building process is drudgery. I work for a government building department. Same drudgery, better pay.

Those are 'money', that is MoE, to him. He says he wants to define 'money' so that it covers all those, because those are MoE. He wants 'money' to exclude everything that is not MoE, for instance bonds.

I think Nick came up with "M-book", instead of M, partly because he knew that I think in terms of the ledger, not "counters". He also seems to be embracing accounting (as JKH, too, pointed out), and has come to the view that 'money' shouldn't be seen simply as a commodity (like in Clower). With "red money", which he counts as part of M, he clearly divorces from Clower? The garbage metaphor might be his last attempt to hold to it, but garbage is a liability, and a commodity is an asset. So, "M-book" is actually a bastard which was conceived when Clower met an accountant.

I start to sound like Freud, so I'd better go to sleep now. Thanks a lot for the discussions today, guys!

"Roger said: "Keep track of the value of the components sorted by supplier."

You initially talked about physical money being a place-holder. But now you're talking about a unit of account (value of the components)? I don't get it. Where's the place-holder in this second case?"

Hmmm. When we have a queue, we can get a stand-in. This person would preserve our position (value) as well as represent our ownership. In the auto example, the liability side would identify multiple owners, each owning a share of the assets listed on the other side.

Hmmm. Maybe I have an undisclosed assumption here. I am assuming that it takes the auto builder a while to pay the suppliers. Hence, for a while, the supplier has an ownership stake in the auto building entity.

Antti, OK, MoE is then more like an abstraction/category whereas the underlying instrument might vary. However, when I think about red money it appears to be like a promissory note, albeit in inverted form as to what we're usually accustomed to. So, green money is the credit institutions promise to pay the bearer X sum of "currency"; a basic banknote may suffice for such function. Red money is like a bill of exchange by which the bearer of the note promises to pay a third party X sum of "currency". By "currency" we may simply mean the 'current' accepted forms of payment in general circulation – which in this case would be Reds and/or Greens.

So there's cross-symmetry between Reds and Greens in the sense that Red-p = Green-e and Red-e = Green-p.

There's also inverse symmetry in terms of liability-asset distribution in that Red-p (L>L>A) is inversely symmetrical to Green-p (A>A>L) and Red-e (L>A>L) is inversely symmetrical to Green-e (A>L>A).

Both in a Red- or Green-only world it's he drawee who never can rid itself from monetary obligations as long as there's monetary exchange going on. With Greens, it's the third party (banks or the government?) who never can rid itself from such obligations. With Reds, it's the bearer (as a category) who never can.

In a Red-only world, bearers are is born in sin, obligated to the paymaster. Redemption for bearers as a whole comes by way of "selling" goods to the paymaster. Alternatively, with Reds-only, one can walk the full inverse mile, and Red becomes like Green in that liability in Red is the same as an asset in Green. In that case, the payment instruction order would also have to change (reds to the seller and not the buyer).

Antti: You write: "... Except that the ownership stake, or any credit in the books of the manufacturer, is not money. Or is it? You were talking about money as a place-holder."

Hmmm. We have a case where the "exact moment" of ownership change is uncertain (supplies are delivered, payment two weeks later). The supplies are (first) clearly exchanged, then follows a (second) related exchange that is purely monetary. When our goal is to follow the ownership of assets through time, we find it convenient to think that the supplies become money (in a transformation sense).

Hmmm. Maybe another undisclosed assumption here. The supplies -> money would not be a supplies -> PHYSICAL money transformation. The transformation would be supplies -> ("money") -> accounting (which is physical marks).

I understand accounting as a code (cryptography). Done properly, it is an exact translation of the underlying reality. It takes coding skills to master the relationships.